Performance Bond Cost Affected By Financial Statement Quality

We get calls all the time that go something like this. How do you determine rate? How do I lower my rate? If I get a CPA statement, what will my bond rate and capacity be? All these questions have many different answers and they are impossible to answer as a one-size-fits-all approach. There are many ways rate and capacity is determined for performance and payment bonds from type of work, duration of contract, business and personal equity, level of CPA statement, warranty periods, amount of bond needs, among others. For this blog we’ll focus on what it means to upgrade your business financials from in-house financials to a CPA statement, and its effect on bonding rate.

Every small growing contractor in public works will come to a point that their bond agent and/or banker will tell them to upgrade their financial presentation to a CPA statement in order to get larger performance and payment bonds. As surety professionals we rely on accurate financial information to underwrite bonds, which in large part leads to the determination of a bond amount for which each company qualifies. Once a contractor decides to upgrade its financials there are 3 levels of assurance for CPA statements – compiled, reviewed, and audited. In most cases for businesses making the transition from in-house to CPA statement, the bond agent will advise to get a reviewed financial on a percentage of completion basis from a CPA that specializes in construction.

So how does upgrading to a CPA statement reduce rate for performance bonds? The statement alone does not necessarily reduce rate. By getting a CPA statement, it usually means that the contractor’s bond agent feels like the contractor is ready to move from a non-standard surety to a standard surety. Non-standard sureties write bonds on in-house financials, with collateral or fund control, credit issues, etc. There is more work involved and thus, comes with a higher fee. Standard sureties generally require a quality CPA statement. In addition, many will require a certain level of equity, strong balance sheets, etc., all leading to a more sound company and justifying a lower fee.

It’s hard to predict when the right time to move from in-house financials to CPA statement so doing a cost/benefit analysis is important. Again, there’s no one-size-fits-all approach but the below matrix can be used as a rule of thumb regarding cost of statement and surety rate.

Level of statement

Cost

Premium rate

Notes

In-house

Minimal

2.5-3%

These are generally flat rates and range shown to the left depends on surety

Compiled

$2k – $5k

2-3%

These are also generally flat rates and while it adds a little confidence for the underwriter, the level of CPA assurance isn’t going to reduce rate much, if at all.

Reviewed

$6k – $20k

.5 – 2.5% sliding

Once a contractor is at this level, they can expect a tiered rate that starts higher and reduces as contract increases. Some will start at 2.5% and slide down, others start at less than 1% and slide down from there. And several rates in between.

Audited

$20k +

.5-1.5% sliding

Once a surety requires an audit level, cost of premium is probably not an issue with the contractor. An audit level would be required when a bond program exceeds a certain level.

As another general rule of thumb, if a contractor performs about a $1 million worth of annual bonded work, the cost of the CPA reviewed financial will reduce the premium rate to where the cost is a wash. Example:

Contractor A does a $1 million project at a flat 2.5% premium rate = $25,000.

Contractor B does a $1 million project on a tiered 2.5/1.5/1 tiered rate = $13,500

You can see that in this scenario, the reduction in rate pays for the cost of the CPA statement. Not to mention, having a quality CPA statement comes with the benefits of tax planning, consultation, succession planning, etc.

A contractor should be able to discuss these scenarios with a surety professional who truly understands the cost/benefit of upgrading their financials. At Surety 1, this is what we do all day, every day. Feel free to call us with any questions about rate and/or your bond program.

Supplemental information is not required. I met with a quality CPA firm yesterday. The equity in my organization is excellent, the balance sheet is strong. These CPA are to issue a Review level opinion on my Finacial Statements. Even though these CPAs have an excellent reputation, and my equity is good, they are insisting that my FS include in Supplemental information a reconciliation and detailed schedule of beginning WIP, sales, and ending WIP. This schedule is of no value to me, but they say the bonding agent wants it. Because the accounting boards FASB state this schedule is not necessary I disagree. If the schedule was necessary, this schedule would be included in the notes to the FS. As you know, the notes are significant portion of the FS, and are Required. My organization is lean, and preparing an unnecessary schedule would be an unreasonable burden. The CPASs offered to assist in preparing this schedule. Be aware that the accounting literature says this is My schedule, but the independent CPAs would actually be preparing the schedule at I assume at a heathy cost. I see an independence issue along with spending money on a schedule with limited value.